Consider a one period binomial model of a currency option on the dollar. The current (date t = 0) spot exchange rate is S0 = 75 pence per dollar. The spot rate at the end of the period will be either Su = 100 pence or Sd = 60 pence. The UK risk-free interest rate over the period is rs = 1/3 (33.3333%) and the US risk-free rate of interest is rd = 1/4 (25%). There is a call option with a strike price of K = 68 pence and a forward contract with a price of F = 80 pence. Show how to use the forward contract and the UK money market to replicate the payoffs to the call option and hence, find the price of the call option.
Consider a one period binomial model of a currency option on the dollar. The current (date t = 0) spot exchange rate is S0 = 75 pence per dollar. The spot rate at the end of the period will be either Su = 100 pence or Sd = 60 pence. The UK risk-free interest rate over the period is rs = 1/3 (33.3333%) and the US risk-free rate of interest is rd = 1/4 (25%). There is a call option with a strike price of K = 68 pence and a forward contract with a price of F = 80 pence. Show how to use the forward contract and the UK money market to replicate the payoffs to the call option and hence, find the price of the call option.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Consider a one period binomial model of a currency option on the dollar. The
current (date t = 0) spot exchange rate is S0 = 75 pence per dollar. The spot rate
at the end of the period will be either Su = 100 pence or Sd = 60 pence. The UK
risk-free interest rate over the period is rs = 1/3 (33.3333%) and the US risk-free
rate of interest is rd = 1/4 (25%). There is a call option with a strike price of
K = 68 pence and a forward contract with a price of F = 80 pence. Show how to
use the forward contract and the UK
call option and hence, find the price of the call option.
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